PREVIEW: Regulatory Cloud Hangs Over Derivatives Conference

The global derivatives exchange industry has had a good economic crisis. The systems worked, and a heart focused on price discovery, risk management and making money never skipped a beat.

So why don't the regulators get it, wonder executives gathered for a major industry conference in Chicago starting Wednesday?

The threat and uncertainty of regulatory crackdowns on listed derivatives worldwide has replaced slumping volume and rogue traders in executives' bad dreams.

"It's true we have fewer friends in Washington," said John Damgard, a key architect of existing futures regulation and president of the Futures Industry Association, which hosts this week's gathering.

"There are powerful people in political positions that want to make our industry smaller."

Though the industry's central clearing model has been embraced by the Obama administration as a way to reduce risk in over-the-counter markets, derivatives exchanges face new rules capping commodities trade and limiting short-selling of stocks, along with scrutiny over order types and the possibility of a tax on transactions.

Washington-related worries have dampened the industry's mood despite signs of stabilization in trading activity and the potential for merger and acquisition activity to ramp up again, following reports that CME Group Inc. (CME) could purchase the CBOE in a home-grown deal valued at $5 billion.

Last year the derivatives industry successfully fought off a push for tighter limits, citing studies by the Commodity Futures Trading Commission and exchanges themselves showing that speculative investors played little role in the historic run-up of commodity prices.

Though energy and agriculture prices have come down a year later, exchanges now seem poised to lose the same debate.

New CFTC Chairman Gary Gensler, with the support of some in Congress, is looking to impose such limits while scaling back current exemptions given to banks. The CFTC is also seeking the authority to impose limits across over-the-counter markets.

Gensler is slated to address the gathering Wednesday morning.

CME, which stands to lose the most business if commodity traders face tougher caps, continues to make its case and remains hopeful that Washington won't make changes that wind up driving investors to overseas or off-exchange markets.

"While some people have strong views, they're coming around to the empirical evidence and the economic impact that these issues have," said CME CEO Craig Donohue.

CME has warned that farmers and energy companies could take a hit without commodity investors to help hedge their risk.

Damgard, of the Futures Industry Association, sees limitations to the industry's usual approach of testimony and educational outreach, and the FIA has turned to the end-users of derivatives--banks that help airlines, agribusiness companies and other industries hedge against commodity price moves-- to help make the case in Washington.

Options exchanges like the CBOE and the International Securities Exchange face new rules for short-selling, which could make it harder for market-makers to operate, as well as a potential ban on step-up orders that have been criticized for giving some high-speed trading firms an unfair advantage.

"It's safe to say that politics is playing a stronger role than ever before," said Gary Katz, chief executive of the ISE, who said that regulators are under tremendous pressure for missing clues about the credit crisis and miscreants like Bernard Madoff.

"It's always harder, when there's a populist undertone, to try and use hard, cold analysis," said William Brodsky, chief executive of the Chicago Board Options Exchange, who acknowledged that relatively minor issues have received a "disproportionate amount of attention from Congress."

Brodsky, who also heads the World Federation of Exchanges, warned that in the meantime momentum could be slipping away for reforming the over-the-counter markets that played a much bigger role in the credit crisis.

"We're not saying there isn't room for improvement in our markets," Brodsky said. "But given the near-collapse we just escaped, we might be better served by focusing on the accelerant that fueled it."

-By Jacob Bunge, Dow Jones Newswires; (312) 750 4117; jacob.bunge@dowjones.com

(Doug Cameron contributed to this article.)

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